Proposed Regulations Clarify Rehabilitation Credit
The IRS has released proposed regulations regarding changes made to the Internal Revenue Code’s Section 47 rehabilitation tax credit under the Tax Cuts and Jobs Act (TCJA). The regulations address several taxpayer concerns that have arisen in the wake of the law’s passage, including how the credit should be allocated.
Prior to the TCJA, Sec. 47(a) provided a two-tier credit for qualified rehabilitation expenditures (QREs) incurred in connection with a qualified rehabilitated building (QRB):
- A 20% credit for QREs related to a certified historic structure, and
- A 10% credit for QREs related to a QRB other than a certified historic structure (certain buildings first placed in service before 1936).
Taxpayers were allowed to take the full amount of the credits in the tax year the QRB was placed in service.
The TCJA generally repealed the 10% credit for pre-1936 buildings, and modified the rules for the 20% credit, for QREs paid or incurred after December 31, 2017. Sec. 47(a)(1) now provides that the rehabilitation credit must be claimed “ratably” over a five-year period, beginning in the taxable year in which a QRB is placed in service.
Some taxpayers have questioned whether the credit is determined in the year the QRB is placed in service and allocated ratably over the five-year period or whether five separate credits are determined during each year of the five-year period. The proposed regulations make clear that the first approach is correct.
The rehabilitation credit for any taxable year during the five-year period is the “ratable share.” The ratable share is 20% of the “rehabilitation credit determined” for the QRB.
For example, suppose a taxpayer incurs QREs of $200,000 on a QRB placed in service in 2021. The rehabilitation credit determined in that year is $40,000 ($200,000 x .20). For each tax year during the five-year period beginning in 2021, the ratable share is $8,000 ($40,000 x .20).
Note that the rehabilitation credit amount is different if the taxpayer claims additional first-year bonus depreciation. In that case, the credit is 20% of the remaining rehabilitated basis of the QRB for the tax year the building is placed in service.
Taxpayers may rely on these proposed regulations for QREs paid or incurred after December 31, 2017, in taxable years beginning before the Treasury Department adopts final regulations. Before final regulations are issued, taxpayers should follow the proposed regulations consistently and in their entirety.
The TCJA includes a transition rule for QREs related to any building owned or leased by the taxpayer on or after January 1, 2018, that could mean an ongoing project is eligible for either the 10% or the 20% credit claimable in its entirety in the year the QRB is placed in service. Contact your tax professional to help you navigate this and the other rules in the most tax-favorable manner.